 Oh, and welcome to the session in which we'll discuss the third income tax problem, which involved the third tax assets and the third tax liabilities. In my opinion, if you can understand this problem, if you can solve this problem, you should be able to answer any questions you are faced with on the CPA exam or in your intermediate accounting course. The only two things I kept out of this problem is permanent differences and allowances, which I believe they are minor relative to the topics that we're going to be discussing today. Because if you can solve this problem, you should be able to understand how permanent differences work, how allowances work. Obviously, I have lessons and examples for those two aspects, permanent differences and allowances in a separate session. First, I'm going to go over what we are giving, then I'm going to tell you what we need to compute, then we're going to go ahead and compute it. So the following fact relate to Adam Corporation. The third tax liability, January 1st, $60,000. The third tax asset, January 1st, $20,000. This is year X1. So what I'm going to do, I'm going to start by basically plugging in, creating a T-account, the third tax asset, $20,000. The third tax liability is $20,000. Taxable income for 20X1 is $210,000. Well, we need to understand this is the IRS taxable income, so we are responsible for paying taxes on $210,000. Cumulative temporary differences at December 31st, given rise to a future taxable amount of $460,000. Well, what does that mean? It means by the end of the year, your future taxable amount, your future future taxable amount now is $460,000. And we're going to see how we're going to use this information. Remember, before we see how we're going to be using this information, what does future taxable amount mean? What does it result into a result in DTL? Because if you have future taxable amount that's going to result in future taxes, you have more responsibilities, more liabilities. Cumulative temporary differences at December 31st, given rise to future deductible amount, $190,000. What do future deductible amount give rise to? Future deductible amount give rise to the third tax asset, and they should be $190,000. The tax rate for all years is 20%. Again, I'm also not playing, not changing future tax rate, which is 20%. That's something I also ignored in this problem. No permanent differences, as I told you, I'm not going to discuss this. The company, which is discussed in a separate session with a comprehensive example, the company is expected to operate profitably in the future. It means there's no need to create an allowance. Okay, everything is giving. The first thing we need to compute is pre-tax financial income or gap income, because we are giving IRS income. Sometime you are giving IRS, you have to come up to GAP, which is pre-tax financial income. Sometime you might be giving pre-tax financial income and going to IRS. You need to know how to go back and forth between the two. And this is not a tricky, you have to have a good understanding of it, which we will work in this problem. Then they're going to ask us to prepare journal entries to record income tax expense, deferred income taxes, income taxes payable, then prepare the income statement section to show how the income statement expense is presented. Let's go ahead and get started. Now, starting with, we are told here that a future taxable amount is 460,000. That's fine. What does future taxable amount lead to? Lead to D to L. Now, we already have in deferred tax liability D to L already 60,000. So because we have already 60,000, this 60,000 arises from some difference in the past. So this 60,000 is coming from somewhere. It's coming from somewhere. What is that somewhere? Well, we had some differences in the past and it gave us 60,000 in the third tax liabilities. Well, what does that mean? It means sometime in the past we had a difference and that difference we multiplied by 20% gave us 60,000. So we had some difference, some future taxable amount. That future taxable amount we multiplied by 20% will give us 60,000. Therefore, to find the 300,000, I'm going to take this. I'm going to work backward, take the 600,000 divided by 0.2. 20% will give us, this is the previous. This is the previous taxable amount. This is the amount from previous year that gave us this existing 60,000 dollar that's giving in the problem. Now what we are told, what we are told is this. We are told that the cumulative, cumulative temporary differences that give rise to a future taxable amount is 460. It means the future taxable amount actually increased went from 300 to 460. So it went from 300 to 460. Therefore, 460, which is giving to us minus 300 that we computed. It means this year we have additional future taxable income of 160. What does that mean? It means our deferred tax liability, it's going to increase. It's not reversing, it's increasing. It's increasing. How much it's increasing by? It's 20% of 160. So we have an additional $32,000 to book in deferred tax liabilities. So there was no reverse in the deferred tax liabilities. If anything, the deferred tax liabilities went up. So the deferred tax liabilities could go up. The deferred tax liabilities could go down, which means it reverse. For this year, actually it kept on increasing. Therefore, what we need to do, we need to increase the deferred tax liabilities by 32,000. So now the balance in the deferred tax liabilities is 92. You could be given this sets of facts and ask what is the balance in the deferred tax liability at the end of the year? Or what is the adjusting entry? Well, the adjusting entry, 32,000, which we will discuss later. So this is how we compute the deferred tax liability component, which we have to increase by 32,000. The next thing we look at is the deferred tax asset, but before we do so, I would like to remind you whether you are a student or a CPA candidate. You must be either a student or a CPA candidate to be watching this. This is how you end up here. If you end up here, great. What I'm going to ask you to do is to go to my website, farhatlectures.com. Take a look at my material. I can help you pass the CPA exam. I provide supplemental material that's going to help you with your accounting courses and your CPA resources, such as lectures, PowerPoint, PowerPoint, multiple choice, true, false. This is a list of all my accounting courses, actually a partial list. My CPA material is aligned with your Becker, Roger, Gleam, Wiley, any other CPA review course you are taking. I give you access to 1,500 previously released AI CPA questions with detailed solution. If you have not connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation. Like this recording, share it with other. If it's helping you, obviously you are watching me. Please share it with other. It might help other. Connect with me on Instagram, Facebook, Twitter and Reddit. And I started a CPA exam support group for CPA candidate. Please join us to discuss your CPA exam journey with me as well as with other CPA candidate. Now let's focus on the third tax asset. Already in the third taxed asset, we have $20,000. Well, this $20,000 is a deferred taxed asset. Well, how did that $20,000 came into existence? Sometime in the past, we had $20,000 divided by .2. We had $100,000 of future deductible amount. So 100,000 times 20% equal to 20,000. So this is how $20,000 came into existence. Now we don't know why. For example, maybe I should have just maybe a little bit more specific. For example, this $300,000 in the past was the result of the difference in accrual income and cash income. So let's go back to here to the third tax liability. Why did we have this $300,000 and the additional $160,000? It could be that we are debiting account receivable, crediting sales. It means we are recording revenues for certain transaction on accrual basis. And we did not receive the cash yet. Therefore, it's not taxable. That's why it's going to give us future taxable amount, which is D2L. Just kind of so you know where this $300,000 coming from. This is one source of it. The deductible amount, this could be, for example, where we have a warranty. When we have a warranty, what we do is for financial accounting purposes, we debit warranty expense, credit, a liability. This is for financial accounting purposes. For tax purposes, we don't do anything because we don't expense the warranty until we pay for it. Therefore, what's going to happen, this warranty, it's going to give us future deductible amount. Just in case you're wondering, what does future taxable amount mean? What does future deductible amount mean? Well, I have a whole lesson, like 20-minute lesson explaining every aspect of this. But the point here is in the past we had $100,000 of deductible amount. Now, what we have now is they're telling us this amount, this amount, the cumulative amount went to $90,000. It means again, the deferred tax could reverse, the deferred tax could go up here. The deferred tax, it looks, it went up. It went from $100,000 to $190,000. So $190,000 minus $100,000, it increased by $90,000. Again, now we have to increase our deferred taxed asset. We'll take $90,000 times 20%. We'll give us $18,000 in additional deferred taxes. Therefore, we add $18,000 to our deferred taxed asset, and our deferred taxed asset is $38,000. Well, we did all this computation, but we have not answered any of the questions that we are giving. Actually, partially, but this is what you have to do. This is what you have to answer to answer all the questions. Again, back to the question. The original question is, what is GAP income for this company? What is GAP income? Because we are giving IRS income. We're not giving GAP income. What are giving IRS income is $210. Now, what we have to do is this. How do we go from GAP income to IRS income? Here's what we do. We'll take GAP income, then we'll find the differences, whatever those differences are, and we'll get to the IRS income. Well, do we have GAP income? No, we don't have GAP income. So a GAP income, pre-tax financial income is X. It's unknown. But we know, we know for a fact that there was an increase in temporary difference of 160. What does that mean? It means somehow, when we got to pre-tax financial income, we had 160,000, and I said this is going to be revenue on a cruel basis. So this pre-tax financial income should include 160,000 in revenue, which is not revenue for tax purposes, because this increase in income led to a future taxable amount. It means we have to deduct this 160. So whatever X is, pre-tax financial income, we have to deduct 160. Also, we know that this number pre-tax financial income, X, included a deduction of 90,000. Remember the deduction I assumed, I told you, let's assume this is a warranty expense. So we deducted 90,000. We added revenue 160 to come up with pre-tax financial income. When we're going from pre-tax financial income to IRS income, we have to do the opposite. We have to add this 90,000 that we deducted. Now, so X, which is pre-tax financial income, gap income, minus 160, plus 190, gave us the IRS income that's given to us 210. Now, all we have to do is solve for X. If my math is right, pre-tax financial income or gap income is 280,000. 280,000. So I hope this makes sense. I hope this makes sense because if you understand how we went from gap to IRS, it means you know the differences. And this is helpful when you are completing your income tax course and you are looking to complete schedule M1. So if you're familiar with schedule M1, this is easy for you or it should be understandable. So actually finally good, we answered the first question. Gap pre-tax financial income is 280,000. And while IRS, we're gonna only pay the IRS based on 210,000, okay? Now, let's see if we can prepare the journal entry for income tax expense, the third income tax is an income taxes payable and present. So this is the same information that I did the computation for in the next slide. Again, when we do the journal entry, as I always tell you in the previous recording, we start by computing income taxes payable. How do we compute income taxes payable? We take IRS income multiplied by the tax rate. So our income taxes payable is 42,000. We credit income taxes payable 42,000. So this is part of the entry. We already computed the increase in the third taxes. We're gonna increase the third taxes. Debit the third taxes, 18,000. We already computed the increase in the third tax liability, 32. We credit the third tax liability, 32. Once again, for the sake of this example, both DTA and DTL went up, okay? Just as it happens, sometimes they reverse. They go down, so you have to know how to deal with this. Now remember, income tax expense, this number is a plug. Income tax expense is a plug. What is that plug? Well, here's what happened. We're gonna have to pay the IRS 42,000 income taxes payable. Then our deferred component went up by 14. We have a net increase in assets. So 32 minus 18 equal to 14. So we have a deferred tax asset of 14,000. It means in the future, we're gonna have additional savings on our tax. But for now, we have an income tax expense of 56,000. For now, the gap income is higher. Gap income is higher. Therefore, our income tax expense is higher. Why? Because we're paying 42,000 now. But we have future savings, net 14,000 into the future. Net 14,000, therefore, if we take 74 minus 18, we'll give us 56. So income tax expense is a plug. Simply put, here's what I did. I said 42,000, what I have to pay now. Plus, I have future saving of 32 minus my future taxable amount of 18 will give me 56,000. Also, I want you to see the numbers of it. So this is the entry. This is the entry. And this is why I did all these computation at the beginning to get you to the entry. And on the CPA exam, don't start to go through my computation the way I did it. They could be asking you one simple question. For example, they could only ask you, what is your income tax is payable? That's easy. I'm gonna take what is giving 210 times 20%. So don't start to do what I'm doing. Compute the third tax library. Compute the third tax asset. Because you don't need those numbers if the question is income tax is payable. If the question is what is the increase or decrease in the third tax asset, you will answer that question. First, always read the question because you could be giving so many different questions about this sets of fact. We're not done yet. The last thing we need to do is to present the income tax expense on the income statement. How do we do so? Well, we're gonna take pre-tax financial income which we already computed, 280,000 minus income tax expense. Income tax expense has two component, a current component which is income tax is payable and the third component which is a net of 14. So 280 minus taxes of 56,000 will give us net income of 224,000. This is gap financial statement. What should you do now? Go to farhatlectures.com and start to work multiple choice through false exercises that's gonna help you reinforce the concepts that you learned. Look, invest in yourself. Don't shortchange yourself. Your accounting education is important. Your professional certifications are important. You spend two to three years studying, putting the certifications behind you. Then you can focus on your career for the next 20, 30, 40 years, whatever you want to do. Good luck, study hard, stay motivated and of course, stay safe.